Emergence of Islamic Banking

For an expanding economy, a developed and efficient banking system is indispensable. Among others, it helps transfer of financial resources from surplus units to deficit units and, hence, helps accelerate the pace of development by securing uninterrupted supply of financial resources to people engaged in numerous economic activities. The tremendous development that the world economy has experienced in the last few decades was contrib´┐Żuted by several factors among which, growing institutional supply of loan able funds must have played the pivotal role. The role of banking is comparable to what an artery system does in the human body. Both commercial banks and other development financial institutions provide short-, medium-, and long-term credits to businesspersons and entrepreneurs who usually take the lead in ventures of economic development.

What is Islamic Banking

Islamic Banking: Some Conceptual Issues What is Islamic Banking Islamic banking has been defined in a number of ways. The definition of Islamic bank, as approved by the General Secretariat of the OIC, is stated in the following manner. "An Islamic bank is a financial institution whose status, rules and procedures expressly state its commitment to the principle of Islamic Shariah and to the banning of the receipt and payment of interest on any of its operations"(Ali & Sarkar 1995, pp.20-25). Shawki Ismail Shehta viewing the concept from the perspective of an Islamic economy and the prospective role to be played by an Islamic bank therein opines: "It is, therefore, natural and, indeed, imperative for an Islamic bank to incorporate in its functions and practices commercial investment and social activities, as an institution designed to promote the civilized mission of an Islamic economy" (Ibid). Ziauddin Ahmed says, "Islamic banking is essentially a normative concept and could be defined as conduct of banking in consonance with the ethos of the value system of Islam" (Ibid). It appears from the above definitions that Islamic banking is a system of financial intermediation that avoids receipt and payment of interest in its transactions and conducts its operations in a way that it helps achieve the objectives of an Islamic economy. Alternatively, this is a banking system whose operation is based on Islamic principles of transactions of which profit and loss sharing (PLS) is a major feature, ensuring justice and equity in the economy. That is why Islamic banks are often known as PLS-banks.

Objectives of Islamic Banking

The primary objective of establishing Islamic banks all over the world is to promote, foster and develop the application of Islamic principles in the business sector. More specifically, the objectives of Islamic banking when viewed in the context of its role in the economy are listed as following:

  • To offer contemporary financial services in conformity with Islamic Shariah;

  • To contribute towards economic development and prosperity within the principles of Islamic justice;

  • Optimum allocation of scarce financial resources; and

  • To help ensure equitable distribution of income.

RIBA and Profit

There are persons who try to equate Riba with profit. In effect, they are fundamentally different from each other as can be seen from the following:

Riba Profit
1. When money is "charged", its imposed positive and define result is Riba 1. When money is used in trading (for e.g.) its uncertain result is profit.
2. By definition, Riba is the premium paid by the borrower to the lender along with principal amount as a condition for the loan. 2. By definition, profit is the difference between the value of production and the cost of production.
3. Riba is prefixed, and hence there is no uncertainty on the part of either the givers or the takers of loans. 3. Profit is post-determined, and hence its amount is not known until the activity is done.
4. Riba can not be negative, it can at best be very low or zero. 4. Profit can be positive, zero or even negative.
5. From Islamic Shariah point of view, it is Haram. 5. From Islamic Shariah point of view, it is Halal.